Outlook 2005: Asset servicing

Continued consolidation, technology upgrades likely

Tight margins and high capital costs are expected to keep asset-servicing banks in each others' crosshairs, though some industry executives don't see any consolidation this year.

"The watchword as we go into 2005 and 2006 is really continued consolidation," said Patrick Curtin, executive vice president at Bank of New York. "All of us expect to see continued consolidation in the asset-servicing business. It's no great secret that profit margins are under pressure and the business continues to be very capital intense."

He said 2005 will likely set the consolidation stage for activity in 2006 and 2007.

"There will be fewer (global custody) providers at the end of 2007 than there are today," Mr. Curtin said.

The last big custody deal was in January 2003, when State Street Corp., Boston, acquired the custody business of Deutsche Bank's Global Securities Services for $1.1 billion. But last November, Chicago-based Northern Trust Corp. agreed to pay ING Group, Amsterdam, The Netherlands, $483 million for Baring Asset Management's financial services group.

Global opportunities

Jay Hooley, executive vice president and head of State Street's investor services business, agreed that consolidation would be on the minds of asset servicing executives, and he said it would be driven by global growth opportunities.

"I think some of the better, higher-growth opportunities in this business are in emerging spaces like continental Europe," he said, citing Dublin, Jersey and Luxembourg because of the amount of offshore fund business they manage. "I think people can go to a single country and provide solutions, but I think the game will be played on a multinational basis.

"Knowing that at State Street about 80% of our revenues are derived from this (asset servicing) business, it's hard for me to imagine many players are going to be able to muster the financial resources to do what it's going to take to provide integrated multinational servicing," he said.

According to Mercer Securities analyst Imran Gulamhuseinwala in London, the custody business is ripe for one more "megamerger" or out-of-sector acquisition, and consolidation among midtier custodians is also likely. In a recent report, Mr. Gulamhuseinwala also suggested that custodians are likely to consider clearing firm or niche servicing acquisitions in the clearing business, or exit the subcustody business because of low profitability.

James Palermo, vice chairman of Mellon Financial Corp., Pittsburgh, is responsible for the firm's asset servicing business. He said consolidation is likely to be in pieces, with custodians picking up a hedge fund administrator or offshore administrator.

"Amongst the largest global players, my sense is that over the next several years, that number will decline," he said. "It won't go to two or three — I don't think you're going to see that kind of consolidation — but in any industry, as long as there's excess capacity, you're likely to see some consolidation."

Bank of New York's Mr. Curtin declined to name likely targets or acquirers but said any activity is not likely to be limited to small or niche players.

"I don't necessarily mean that only the niche, tangential regional providers will exit the business," he said. "In fact, an argument could be made for the continued existence of the niche, regional specialized provider. But even among bulge-bracket custodians, there's a decent likelihood that consolidation will occur."

Executive attention

Given the economics of being a global custodian — high fixed costs, heavy capital investing and narrow profit margins — global custody requires "an incredible amount of executive management attention on them," he said. "It's not simply enough to be a big global custodian. It's crucial that global custody be a part of who you are as an institution."

Amid this backdrop, asset servicing banks are expected to continue evolving into information gateways as plan sponsors, investment managers and other institutional investors seek to control costs and, ultimately, pick up alpha, by managing their information flow better, from investment decisions to post-trade analytics and reporting.

"The realization that we are less and less about being providers of custody of securities and more and more about being providers of custody of investment information will pick up speed," Mr. Curtin said.

"This is a different paradigm than the paradigm that existed for custodian services 15 years ago," he said. "Then it was almost exclusively about settling trades and collecting proceeds. While all those things are important components of what a custodian — an asset servicer — does, a larger set of activities we provide today have to do with the manufacturing of investment information."

Case in point: Mellon, which is using its Eagle Investment Systems unit to build what Mr. Palermo called a "data-centric" model for asset servicing, as opposed to a "custody-centric" or "accounting-centric" model, which is the norm.

A data-centric model houses all data and information in one central data repository so when a plan sponsor or investment manager needs information quickly on its holdings in a certain security, the asset-servicing provider can access that information easily and efficiently, he explained.

"We've seen in the investment world that information is power," he added.

"And the more accurate and the more timely and the more complete that information is equates to more power."

An evolution

T. Andrew Smith, managing director, Citigroup, New York, said the issues most important to asset-servicing clients 10 years ago, such as fail rates on trades, have evolved with technology to now include speed of getting information — and that trend will continue.

"They want to know how quickly can they get (net asset values), how quickly can we pump (the data) through the compliance engine," said Mr. Smith, who is head of the firm's fund and securities services product sales force in North America. "They'll say ‘tell me if I'm winning or losing and tell me how I'm winning or losing — is it because we're picking better stocks or because we're overweighted in a sector?'"